Netflix Earnings Were Great but I’m Not Buying

Hilary Kramer

Hilary Kramer is an investment analyst and portfolio manager with 30 years of experience on Wall Street.
[Netflix]

While everybody has an opinion on Netflix (NASDAQ:NFLX), the Jan. 17 earnings report that it released after the markets closed didn’t change a lot of minds.

The bulls who had talked the stock up 55 percent since Christmas were relieved to see the paid audience grow by 8.84 million people, well above the 7.6 million management had told us to expect. In the bulls’ view, it’s a great thing that Netflix managed to expand its reach without handing out too many discounts or letting content production costs spiral out of control.

But they’re not the people management needed to convince. And while we heard a lot of great things during the conference call with Netflix management, none of the comments changed my mind.

Netflix is an exceptional company. It is winning the streaming media wars practically before they even have started.

The problem is that its management’s ambitions seem to stop there. In this case, the stock has already gone as far as it can.

I haven’t recommended the company since 2016, when it made money for Turbo Trader and my elite Inner Circle. We’ve moved on.

Follow the Plot, Not the Buzz

The company just isn’t necessarily poised to become a global juggernaut following the Amazon (NASDAQ:AMZN) or even Facebook (NASDAQ:FB) model.

At the end of the day, Netflix is going to be an international entertainment provider that remains just one of many channels coexisting on the map and competing for viewers’ time.

That business will ultimately hit a scaling limit. After all, there are only 1.1 billion people in the developed world and their collective video budget is finite. Even if Netflix can sign them all up and charge an average of $8.99 a month, that’s only half the revenue pool Amazon is working with now.

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Granted, even though emerging markets represent huge audience potential on top of that, the pockets get shallower the farther you get from North America. Take Facebook as a benchmark. If that company squeezes 9 percent as much revenue out of each user in Asia as it does in its home market, then Netflix bulls need to accept that after the first one billion subscribers, the cash just won’t stack up as fast.

Besides, that billion-person audience is still a long way away. While management is confident that it can keep growing the international presence 40 percent compounded annually, we need to look past 2026 to reach full market saturation.

A lot can happen to derail a growth curve in seven years, but even if Netflix avoids unforeseen shocks, growing beyond half of Amazon’s current size is going to be a matter of diminishing returns.

Just Another TV Channel

In the meantime, of course, every net subscriber that Netflix gains will remain expensive. That’s simply the cost of being a credible player in the entertainment business.

Look to entrenched channel operators like CBS (NYSE:CBS) or movie studios like Lionsgate (NYSE:LGF.A) for comparisons. Neither of these companies pay once to develop a library of content to capture an audience and then stop spending. There’s no “sweet spot” where you can live forever on reruns.

I suspect that’s why Netflix didn’t release a 2019 development budget last night. The company leaders don’t see the costs ramping down in the foreseeable future.

Odds are much higher that the costs will only accelerate as the company tries to expand into international markets. Gauging domestic taste is challenging enough. Doing it successfully across multiple countries in the long term is practically a miracle.

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The fact that multiple channels have evolved in each of those markets has proven that it’s impossible to satisfy everyone at once. No modern entertainment company will ever achieve a 100 percent share of the audience.

That’s actually a constructive aspect of the Netflix business model that a lot of people miss: there can and will be multiple winners as entertainment begins to shift to streaming delivery.

Netflix doesn’t need to eliminate every other streaming service. All it needs to do is to make sure it remains relevant enough to pay the bills and keep shareholders happy.

As streaming services multiply, they only incidentally threaten each other. Their real threat is to the conventional TV cable-and-advertising ecosystem.

After all, HBO and other premium channels coexisted with movie studios for decades. HBO and Netflix coexist now.

Families that are serious about television subscribe to both services along with Amazon. They’ll probably pay Disney month to month when that company’s streaming channel eventually launches.

Even after the recent price increases, those four packages might cost $50 a month in exchange for practically unlimited content on demand.

Don’t compare them to each other. In a world where the typical U.S. household pays $107 a month for cable, there’s a lot of room for cord-cutters to add streaming services and still come out ahead.

Cord-cutting is hurting cable companies in Europe, too. In Asia, millions of people are jumping straight to streaming, bypassing the set-top box altogether.

And that’s Netflix management’s real ambition. Once the cable box dies, there’s room in just about every budget for at least one streaming subscription.

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Last night, the company bragged about a 10 percent share of all online entertainment minutes, including video games. From what I see in my family, that will probably be the ceiling as new options begin to emerge.

There’s no existential threat here from new streaming channels. But if this is as good as it gets, I’m going to recommend other stocks instead.

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